chapter 8 consolidated finanical statemetns

8/12/2019 Chapter 8 Consolidated Finanical Statemetns

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Consolidated FS-Intercompany Transactions 2

Objectives of the Chapter

To discuss the accounting andworking paper eliminations for relatedparty transactions between a parentcompany and its subsidiaries for:

I. intercompany transactions not

involving profit or loss such as loanson promissory notes, leases ofproperty under operating leases andrendering of services;


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Objectives of the Chapter (Contd.)

II.intercompany transactions involvingprofit or loss such as intercompanysale of merchandise, plant assets,intangible assets and leases ofproperty (under capital/sales-typeleases).

P i i l ll h


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Principle to ollow to account or theintercompany transactions for theconsolidated financial statements:

The consolidated financial statementsshould include only transactionsresulting from the consolidated groupsdealings with outsiders.

P i i l t ll t t th


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Principle to ollow to account or theintercompany transactions for theconsolidated financial statements: (Contd.)

Separate ledger accounts areestablished for all intercompany assets,liabilities, revenue and expenses.

These separate accounts clearlyidentify the intercompany items that

should be eliminated in the preparationof consolidated financial statements.


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I. Accounting for Intercompany TransactionsNot Involving Profit (Gain) or Loss

loans on Notes or Open Accounts

The parent company may make

loans to its subsidiaries.The interest rate charged by the

parent company usually exceeds the

parent companys borrowing rate.


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I. Accounting for Intercompany TransactionsNot Involving Profit (Gain) or Loss (Contd.)

Intercompany ledger accounts areused by the parent and the subsidiaryto account for these intercompanytransactions in order to differentiateintercompany loans and loans withoutsiders.

E l 8 1 I t L f



Example 8.1: Intercompany Loans fromPalm (the parent company) to Starr (thesubsidiary)

Assume that Palm Corp. made the followingcash loans to its wholly owned subsidiary,Starr Company, on promissory notes:

Date of NoteTerm of Note,

MonthsInterest Rates,

% Amount

Feb.1, 2001 6 10 $10,000

Apr.1, 2001 6 10 15,000

Sept.1, 2001 6 10 21,000

Nov.1, 2001 6 10 24,000

E l 8 1 I t L



Example 8.1: Intercompany Loans romPalm (the parent company) to Starr (thesubsidiary) (Contd.)

Palm Corp. and Starr Company will use thefollowing ledger accounts to record theforegoing transactions (assuming all notes

were paid by Starr when due):PALM CORPORATIONIntercompany Notes Receivable2001 2001

02/01 10,000 10,000 08/0104/01 15,000 15,000 10/0109/01 21,00011/01 24,000

Bal on11/01 45,000

STARR COMPANYIntercompany Notes Payable

2001 2001

08/01 10,000 10,000 02/0110/01 15,000 15,000 04/01

21,000 09/0124,000 11/01

45,000 Bal on11/01

E l 8 1 I t L




Intercompany InterestReceivable

2001

12/31 1,100

Intercompany Interest Payable

2001

1,100 12/31

Intercompany Interest Revenue

2001

500 08/01750 10/01

1,100 12/312,350 Bal on

12/31

Intercompany Interest Expense

2001

08/01 50010/01 75012/31 1,100Bal on

12/312,350

E l 8 1 I t L




In the working paper for consolidatedfinancial statements for Palm andsubsidiary for the year ended12/31/2001, the foregoing ledgeraccounts appear as shown below:

E l 8 1 I t L




PALM CORPORATION AND SUBSIDIARYPartial Working Paper for Consolidated Financial Statements

For Year Ended December 31, 2001

PalmCorporation

StarrCompany

EliminationsInc. (Dec.)

Consolidated

IncomeStatement

Intercompanyrev. (exp.) 2,350 (2,350)Balance Sheet

Intercompanyrec. (pay.) 46,100* (46,100)

*45,000 + $1,100 = $46,100



Discounting of Intercompany Notes

If an intercompany note receivable isdiscounted at a bank (by the payee,i.e., Palm in example 8.1), the notebecomes payable to an outsiderthebank.

Therefore, discounted intercompanynotes are not eliminated in the workingpaper.



Example 8.2: Discounting ofIntercompany Notes

Continued with Example 8.1 and Assumedthat on 12/1/2001, Palm had discounted at a12% discount rate the $24,000 note

receivable from Starr. Palm would recordthe following entry:Cash 23,940Interest Expense($1,260 discount1,000*) 260

Intercompany Notes Receivable 24,000Intercompany Interest Revenue 200($24,000 x 0.10 x 1/12)



Example 8.2: Discounting ofIntercompany Notes (Contd.)

To record discounting of 10%,six-monthnote receivable from Starr Companydated Nov. 1,2001, at a discount rate of12%. Cash proceeds are computed asfollows:

Maturity value of note[$24,000 + ($24,000 x 0.10 x 6/12)] 25,200

Less: Discount ($25,200 x 0.12 x 5/12) 1,260Proceeds $23,940

*Interest on note that accrues to discounting bank during discounting period.




Palm should inform Starr of the discounting.Starr would prepare the following journalentry on 12/1/2001:

Intercompany Notes Payable 24,000Intercompany Interest Expense 200

Notes Payable 24,000

Interest Payable 200To transfer 10%, six-month note payable toPalm Corporation dated Nov. 1, 2001, fromintercompany notes to outsider notes.




Under the note discounting assumption,the ledger accounts related to theintercompany notes would appear inthe 12/31/2001 working paper forconsolidated financial statements asfollows:





For Year Ended December 31, 2001Palm

CorporationStarr

CompanyEliminations

Inc. (Dec.)Consolidated

IncomeStatement

Intercompanyrev. (exp.) 2,150* (2,150)*

Balance SheetIntercompanyrec. (pay.) 21,700 (21,700) *$200 less than in illustration on page 348 because $24,000 discounted noteearned interest for one month rather than two months.

$21,000 note dated Sept. 1, 2001, plus $700 accrued interest.



Leases of Property under OperatingLeases

When both the parent and subsidiaryaccount the lease as an operatinglease, the lessee will record the leasepayment as intercompany rentexpense, while the lessor will record thelease payment received as

intercompany rent revenue.



Leases of Property under OperatingLeases (Contd.)

For an intercompany operating lease,there is no profit or loss involved.

The inercompany rent revenue wouldbe offset against intercompany rentexpense in the manner similar to theoffset of intercompany interest revenueand expense illustrated earlier.



Rendering of Services

One affiliate may render services toanother and result in intercompany feerevenue and expense (i.e.,management fee charged tosubsidiaries by a parent company).


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Rendering of Services (Contd.)

The intercompany fee revenue andexpense are offset in the workingpaper.

Both the parent company and thesubsidiary should record the fee billingin the same accounting period.

I T A li bl t


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Income Texas Applicable toIntercompany Transactions

No income tax effects associated withthe elimination of the intercompanyrevenue or expenses since no profit or

loss involved in these intercompanytransactions.

It does not matter whether the parent

company and its subsidiaries fileseparate income tax returns or aconsolidated tax return.


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II. Accounting for IntercompanyTransactions Involving Profit (Gain) or Loss

For intercompany transactions involvingprofit or loss, the unrealized profits orlosses must be eliminated in thepreparation of consolidated financialstatements until they are realized.


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The Importance of Eliminating or IncludingIntercompany Profits (Gains) and Losses

Failure to eliminate unrealized profitsand losses would result in consolidatedincome statements that report not onlyresults of transactions with outsidersbut also the results of related partyactivities within the affiliated group.

The Importance o Eliminating or Including


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The Importance o Eliminating or IncludingIntercompany Profits (Gains) and Losses(Contd.)

Similarly, no recognition of realizedgains (losses) would misstate theconsolidated net income.

The management can manipulateconsolidated net income if unrealizedintercompany profits and losses werenot eliminated.


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Intercompany Sales of Merchandise

Types of Sales

Downstream intercompany sales

Upstream intercompany salesLateral intercompany sales


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Intercompany Sales of Merchandise(Contd.)

a. Intercompany Sales at Cost

Example 8.3: Intercompany sale at cost

Assume that Palm sold merchandisecosting $150,000 to Starr during the yearended 12/31/2001 at a selling price equalsto Palms cost.

The ending inventories of Starr on12/31/2001 included $25,000 ofmerchandise obtained form Palm.


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Intercompany Sales of Merchandise (Contd.)

Example 8.3 : (Contd.)

By 12/31/2001, Starr still owedPalm $15,000 for merchandisepurchased during 12/31/2001.

Assuming perpetual inventorysystem for both companies, thefollowing aggregate entries wouldbe prepared by both companies forthe foregoing transactions:


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Palm Corporation Journal EntriesIntercompany AccountsReceivable 150,000

Intercompany Sales 150,000

To record sales to Starr Company

Intercompany Cost of Goods Sold 150,000Inventories 150,000

To record cost of goods sold to Satrr Company.

Cash 135,000Intercompany AccountsReceivable 135,000

To record payments received from StarrCompany


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The following is a partial working paperfor consolidated financial statements ofPalm and subsidiary (include only thedata related to this intercompany saleof merchandise at cost):


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For Year Ended December 31, 2001Palm

CorporationStarr

CompanyEliminations

Inc. (Dec.)Consolidated

IncomeStatement

Intercompanyrev. (exp.) *

Balance SheetIntercompanyrec. (pay.) 15,000 (15,000)*Palm Corporations $15,000 intercompany sales and intercompany cost ofgoods sold are offset in Palms separate income statement in the working

paper.


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Note:

Starr Companys cost of goods sold

and inventories are not affected byworking paper eliminations. BothStarrs cost of goods sold andinventories are stated at cost.

I t S l f M h di


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b.Intercompany Sales with UnrealizedIntercompany Profit in EndingInventories

Without the working paper elimination,the consolidated ending inventory andcost of goods sold are both overstated.

Intercompany Sales of Merchandise


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The ending inventory is overstated forthe mark up of the unsold endinginventory (the unrealized gain).

The cost of goods sold is overstated forthe mark up of the cost of goods sold(the realized gain).


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I t S l f M h di (C td )


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Example 8.4: (Contd.)

On 12/31/2001, Post still owed$30,000 to Sage for merchandise.Both companies use the perpetualinventory system.

The foregoing transactions are

recorded in summary form by thetwo companies as follows:


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Post Company Journal EntriesInventories 120,000

Intercompany AccountsPayable 120,000

To record purchases from Sage.Intercompany Accounts Payable 90,000

Cash 90,000To record payments made to Sage Company.

Trade Accounts Receivable 100,000Sales 100,000

To record sales.

Cost of Goods Sold 80,000Inventories 80,000

To record cost of goods sold.

I S l f M h di (C d )


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Sage Corporation Journal EntriesIntercompany AccountsReceivable 120,000

Intercompany Sales 120,000

To record sales to Post CorporationIntercompany Cost of Goods Sold 96,000

Inventories 96,000To record cost of goods sold to PostCorporation.

Cash 90,000Intercompany AccountsReceivable 90,000

To record payments received from PostCorporation.


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The following working paper elimination isrequired for Sages intercompanys sales ofmerchandise to Post for the year ended

12/31/2001:(b) Intercompany Sales--Sage 120,000Intercompany Cost ofGoods SoldSage 96,000

Cost of Goods SoldPost 16,000Inventories--Post 8,000To eliminate intercompany sales, cost ofgoods sold, and unrealized intercompanyprofit in inventories. (Income tax effects aredisregarded.)


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IncomeStatement

PostCorp.

SageCompany

EliminationsInc.(Dec.)

Consolidated

Revenue:Sales: 5,800,000 1,200,000 7,000,000Intercompanysales 120,000 (b)(120,000)

Costs and

expenses:Cost of goodssold 4,100,000 760,000 (b) (16,000) 4,844,000

Intercompanycost of goods

sold 96,000 (b) (96,000)

POST CORPORATION AND SUBSIDIARYPartial Working Paper for Consolidated Financial StatementsFor Year Ended December 31, 2001



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Contd.

PostCorp.

SageCompany

EliminationsInc.(Dec.)

Consolidated

Balance SheetAssets

Intercompanyrec.(pay.) (30,000) 30,000

Inventories 900,000 475,000 (b) (8,000) 1,367,000

Notes to the Intercompany ales o


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Notes to the Intercompany ales oMerchandise at a Mark Up by a PartiallyOwn Subsidiary

1.The $8,000 unrealized intercompanyprofit is attributable to Sage (the seller,a partially-owned subsidiary).

This unrealized intercompany profitshould be taken into account in thecomputation of the minority interest in

Sages net income for year 2001 (wouldbe illustrated in Example 8.9).

Notes to the Intercompany Sales of


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Notes to the Intercompany Sales ofMerchandise at a Mark Up by a PartiallyOwn Subsidiary (Contd.)

2.Also, this $8,000 would be entered into theSages portion of consolidated retainedearnings on 12/31/2001.

3.If the intercompany sales of merchandiseare made by a parent company or by awholly owned subsidiary, the unrealized

intercompany profit will not have any effecton any minority interest in net income.

This is because the selling agent does nothave minority stockholders.

I t (U li d) P fit i


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Intercompany (Unrealized) Profit inBeginning and Ending Inventories

It is assumed that, on a FIFO basis, theintercompany profit in the purchasersbeginning inventories is realized

through sales of the merchandise tooutsiders during the followingaccounting period.


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Intercompany (Unrealized) Profit in


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Intercompany (Unrealized) Profit inBeginning and Ending Inventories(contd.)

Analysis of Gross Profit

SellingPrice

Cost

Gross Profit(25% of Cost;20%Of Selling

Price)

Beginning inventories $40,000 $32,000 $8,000Add: Sales 150,000 120,000 30,000

Subtotals $190,000 $152,000 $38,000Less: Endinginventories 60,000 48,000 12,000

Cost of goods sold $130,000 $104,000 $26,000



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Sages intercompany sales ($120,000)and intercompany cost of goods sold($96,000) for the year ended

12/31/2001 had been closed to Sagesretained earnings at the end of 2001.

Thus, from a consolidated point of view

Sages 12/31/2001 retained earningswas overstated by $7,600 (95% *$8,000).



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The remaining $400 unrealized profit on12/31/2001 is attributable to theminority interest in net assets of Sage.

The following working paper elimination

would be prepared on 12/31/2002 toreflect the above facts:



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(b) Retained EarningsSage($8,000 x 0.95)* 7,600Minority Interest in Net Assets ofSubsidiary($8,000 x 0.05)

400

Intercompany Sales--Sage 150,000Intercompany Cost of Goods Sold-Sage 120,000

Cost of Goods SoldPost 26,000

InventoriesPost 12,000

To eliminate intercompany sales, cost of goods sold,and unrealized intercompany profit in inventories.(Income tax effects are disregarded.)

*As indicated in Chapter 7 (Page 29), this elimination is posted to the beginning-of-year retained

earnings in the statement of retained earnings section of the working paper for consolidatedfinancial statements.

Issues in Intercompany Profit in Ending


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Issues in Intercompany Profit in EndingInventories and Amount of MinorityInterest A general principle is that all the

unrealized intercompany profit in theending inventory of the buyer (i.e., a

partially owned or wholly ownersubsidiary or a parent), should beeliminated for the consolidated financialstatement as long as the selleris either

the parentor other whollyownedsubsidiaries.


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Issues in Intercompany Profit in EndingInventories and Amount of MinorityInterest (Contd.) The argument is :

The intercompany sale to the minoritystockholder is considered as a sale to

outsiders.Therefore the unrealized intercompanyprofit in the ending inventory attributes tominority stockholders interest should betreated as realized.

It should not to be eliminated in theconsolidated financial statements.



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Issues in Intercompany Profit in EndingInventories and Amount of MinorityInterest (Contd.)

The following table illustrates the typesof intercompany sales and the relatedissues of the unrealized intercompany

profit in the ending inventory:

ssues n n ercompany ro n n ngI t i d A t f Mi it


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ssues n n ercompany ro n n ngInventories and Amount of MinorityInterest (Contd.)

Type Seller Buyer Issue CurrentPractice

A Parent orwhollyownSubsidiary

Partially-ownsubsidiary

Should allunrealizedintercompanyprofit in theending inventoryof the buyerbeeliminated?

All unrealizedintercompanyprofit in theendinginventory iseliminated

B

(as inExample8.4)

Partially-

owna

subsidiary

Parent or

subsidiary

Should all

unrealizedintercompanyprofit in theending inventoryof the buyer beeliminated?

Same as for

type A due toFASBspreference

ssues n n ercompany ro n n ng


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ssues n n ercompany ro n n ngInventories and Amount of MinorityInterest (Contd.)Note to the above table:

a.The unrealized intercompany profit is

attributable to the seller(the partially-own sub.) and must be considered inthe computation of the minority interestin net income of the partially own sub.of the year (see Example 8.4 andExample 8.9).


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Intercompany Sales of Plant Assets

Intercompany sales of plant assetsdiffer from intercompany sales ofmerchandise in two ways:

1. Intercompany sales of plant assetsbetween affiliated companies arerare transactions.

Intercompany Sales of Plant Assets


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Intercompany Sales of Plant Assets(Contd.)

2. Due to the long economic lives ofplant assets, it requires manyaccounting periods before the

intercompany gains (losses) onsales of these assets are realized intransactions with outsiders.


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Intercompany Gain on Sale of Land

Example 8.5:

Assume that on 12/31/2001, Post (the

parent company) sold to Sage (thepartially owned subsidiary) a parcel ofland costing $125,000 for $175,000.The two companies would record thefollowing entries:

Intercompany Gain on Sale of Land (Contd )


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Intercompany Gain on Sale of Land (Contd.)


Post Corporation Journal Entry Sage Company Journal Entry

Cash 175,000 Land 175,000

Land 125,000 Cash 175,000

IntercompanyGain on Saleof Land 50,000

To record acquisition ofland from PostCorporation.

To record sale of land toSage Company



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In the consolidated financial statement,the land should be reported at thehistorical cost and the intercompany

gain should be eliminated until it isrealized (i.e., sold to an outsider bySage).



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The working paper elimination preparedon 12/31/2001 for the intercompanysale of land with gain transaction is as

follows:(c) Intercompany Gain on Sale

of LandPost50,000

Land--Sage 50,000To eliminate unrealized intercompanygain on Sale of land. (Income Taxeffects are disregarded.)



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The above working paper elimination isentered in the working paper forconsolidated financial statements for

the year ended 12/31/2001 as follows:



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POST CORPORATION AND SUBSIDIARYPartial Working Paper for Consolidated Financial Statements

For Year Ended December 31, 2001

Post

Corp.

Sage

Company

Eliminations

Inc. (Dec.)

Consolidated

IncomeStatement

Intercompany gainon sale of land 50,000 (c)(50,000)Balance Sheet

Land (for buildingsite) 175,000 (c)(50,000) 125,000



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No journal entries affecting land wouldbe made by Sage in the subsequentyears due to land is not depreciable.

In the consolidated financial statementsof subsequent years, the land shouldalways be reported at the historical cost

of $125,000 as long as it is not sold toan outsider.



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Therefore, the following working paperelimination applies to all subsequentyears as long as Sage does not sell the

land to an outsider:(c) Retained EarningsPost 50,000

LandSage 50,000

To eliminate unrealized intercompanygain in land. (Income tax effects aredisregarded.)



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p y ( )


Note: The foregoing working paperelimination has no effect on the minorityinterest in net income or net assets of

the subsidiary, because the unrealizedgain is attributable to the seller that isnot a partially own subsidiary.



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p y ( )


Assume that, Sage sold the land to anoutsider for $200,000 in the year ended12/31/2003, the following entry would

be recorded by Sage:

Cash 200,000

Land 175,000

Gain on Sale of Land 25,000To record sale of land to anoutsider.



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p y ( )


A realized gain of $75,000 ($25,000 +$50,000) should be reported on theconsolidated financial statement of

2002. Thus, the following workingpaper elimination is needed:(c) Retained EarningsPost 50,000

Gain on Sale of Land

Post 50,000To recognize $50,000 gain on PostCorporations sale of land to SageCompany resulting from sale of landby Sage to an outsiders. (Income taxeffects are disregarded.)

Intercompany Gain on Sale of


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Intercompany Gain on Sale ofDepreciable Plant Asset

Assume that Sage (the partially ownedsubsidiary) sold machinery to Post (theparent) on 12/31/2001. Details of the

sale and depreciation policy of themachinery are as follows:



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Intercompany Gain on Sale ofDepreciable Plant Asset (Contd.)

Selling price of machinery to Post Corp. $ 60,000Cost of machinery to Sage Companywhen acquired Jan. 2,1999 50,000

Estimated residual value:

To Sage Company, Jan.2,1999 $ 4,000To Post Corporation, Dec. 31,2001 4,000Economic life:

To Sage Company, Jan.2,1999 10 years

To Post Corporation, Dec. 31,2001 5 yearsAnnual depreciation expense (straight-line method):

To Sage Company ($46,000 x 0.10) $ 4,600To Post Corporation($56,000 x 0.20) 11,200



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Intercompany Gain on Sale ofDepreciable Plant Asset (Contd.)

Post Corp. Journal Entry Sage Company Journal EntryMachinery 60,000 Cash 60,000

Cash 60,000 AccumulatedDepreciation($4,600 x 3) 13,800

Machinery 50,000To record acquisition ofmachinery from SageCompany.

IntercompanyGain on Saleof Machinery 23,800

To record sale of machinery

to Post Corp..

The two companies would account for thesale on 12/31/2001 as follows:



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Intercompany Gain on Sale ofDepreciable Plant Asset (Contd.) The following working paper elimination

is required for the consolidated financialstatements on 12/31/2001:

(d) Intercompany Gain on Sale ofMachinerySage

23,800

Machinery-Post 23,800To eliminate unrealized intercompany gain on sale

of machinery.(Income tax effects are disregarded.)



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Intercompany Gain on Sale ofDepreciable Plant Asset (Contd.) The elimination results the machine to

be reported on the consolidatedfinancial statements at its carrying

amount to Sage as follows:Cost of machinery to Post Corporation $ 60,000

Less:Amount of elimination

intercompany gain 23,800Differenceequal to carrying amount

$ 36,200



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te co pa y Ga o Sa e oDepreciable Plant Asset (Contd.) Note: the elimination of the $23,800

gain should be taken into account in theminority interest in the net income of

Sage (the seller) for year 2001. The$23,800 is also included in the Sagesretained earnings, for consolidationpurposes, on 12/31/2001 I (see

textbook 376-378).

Intercompany Gain subsequent to Date of


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Intercompany Gain subsequent to Date ofSale of Depreciable Plant Asset

The following working paper eliminationis required for the consolidated financialstatements of 12/31/2002:

(d) Retained EarningsSage

($23,800 x 0.95)

22,610

Minority Interest in Net Assets ofSubsidiary ($23,800 x 0.05) 1,190

Accumulated DepreciationPost 4,760

MachineryPost 23,800Depreciation Expense-Post 4,760To eliminate unrealized intercompany gain inmachinery and in related depreciation.(Income taxeffects are disregarded.) Gain element in straight-line depreciation computed as $23,800 x 0.2 =

$4,760,based on five-year economic life.

Intercompany Gain subsequent to Date of


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Intercompany Gain subsequent to Date ofSale of Depreciable Plant Asset (Contd.)

The elimination of the Postsdepreciation expense can also beverified as follows:

Posts annual straight-line depreciationexpense [($60,000-$4,000) x 0.2] $ 11,200Less:Straight-line depreciation expensefor a five-year economic life, based onSages carrying amount on date of sale[(36,200-$4,000) x 0.20] 6,440

Differenceequal to intercompany gainelement in Posts annual depreciationexpense $ 4,760

Intercompany Gain in Depreciation


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p y pand Minority Interest

From the consolidation view point, theintercompany gain element of theacquiring affiliates annual depreciation

expense represents a realization of aportion of the total intercompany gainby the selling affiliate .

Intercompany Gain in Depreciation


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p y pand Minority Interest (Contd.)

Thus the $4,760 credit to Postsdepreciation expense in the 12/31/2001working paper elimination increases

Sages net income for consolidatedpurposes.

This increase must be considered in thecomputation of the minority interest inthe subsidiarys net income for the yearended 12/31/2002.

Intercompany Gain in later Years


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The following working paper eliminationis required for the consolidated financialstatements on 12/31/2003:

(d) Retained EarningsSage[($23,800-$4,760) x 0.95]

18,088

Minority Interest in Net Assets ofSubsidiary [($23,800-$4,760) x 0.05] 952

Accumulated DepreciationPost

($4,760 x 2)

9,520

MachineryPost 23,800Depreciation Expense-Post 4,760

To eliminate unrealized intercompany gain inmachinery and in related depreciation.(Income tax

effects are disregarded.)



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p y(Contd.)

Note to the working paper elimination:The sum of the debit amounts forretained earnings and minority interest

in net assets of subsidiary is $4,760less that that in 2002.

This is because $4,760 intercompany

gain has been realized in 2002 throughthe depreciation process in 2002.



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p y(Contd.) The sum of the debit amounts for retainedearnings and minority interest in net

assets represents the unrealized portionof the intercompany gain at the beginning

of the year. For each succeeding year, the unrealized

position of the intercompany gain

decreases (in the amount of $4,760), asindicated in the following summary of theworking paper elimination debits for thoseyears:



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p y(Contd.)

POST CORPORATION AND SUBSIDIARYPartial Working Paper Eliminations-Debits OnlyDecember 31,2004 though 2006

Year Ended Dec. 31,2004 2005 2006

Debits(d)Retained earnings-

Sage $13,566 $ 9,044 $ 4,522Minority interest in

net assets ofsubsidiary 714 476 238

Accumulateddepreciation-Post 14,280 19,040 23,800



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p y(Contd.)

Similar working paper elimination willbe prepared for year 2004,2005 and2006. The changes are only in the debit

accounts as indicated in the abovetable.



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p y(Contd.) At the end of year 2006, the entire

intercompany gain of $23,800 has beenrealized through Posts annual depreciationexpense. The following working paperelimination is required for the machine until itis sold:

Accumulated Depreciation-

Post

23,800

Machinery-Psot 23,800To eliminate intercompany gain inmachinery and related accumulateddepreciation.(Income tax effects are

disregarded.)

Intercompany Lease of Property under


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p y p yCapital/Sale-Type Lease

Land, building, machinery, equipmentand other property may be transferredbetween affiliate entities in the form of a

sales-type lease to the lessor and acapital lease to the lessee.

Intercompany Lease of Property under


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p y p yCapital/Sale-Type Lease (Contd.)

Example 8.6 :Assume that Palm leased equipment

to Starr (the wholly owned subsidiary)

on 1/2/2001 under a sales-type leaserequiring Starr to pay Palm $10,000at beginning of each year starting1/2/2001 through 2004, with abargain purchase option of $1,000payable on 1/2/2005.

Intercompany Lease of Property under Capital/Sale-Type Lease (Contd.)


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yp ( )


Palms implicit interest rate, which wasknown to Starr and was less thanStarrs incremental borrowing rate, was8%.

The economic life of the equipment toStarr was 6 years, with no residualvalue.

The cost of the leased equipment was$30,000.

There were no initial direct costs underthe lease.



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Type Lease (Contd.)


The present value of the minimumlease payment is computed as follows:

Present value of $10,000 each year forfour years at 8% ($10,000 x 3.577097) $ 35,711Present value of $1,000 in four years at8%(1,000 x 0.735030) 735

Palm Corporations net investment in thelease $ 36,506



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ype ease (Co td )

Example 8.6: (Contd.) Journal entries of Palm Corporation for Year

2001:

1/2 Intercompany Lease Receivables[($10,000 x 4)+$1,000] 41,000

Intercompany Cost of Goods Sold 30,000Intercompany Sales 36,506Unearned IntercompanyInterest Revenue ($41,000-$36,506) 4,494

Inventories 30,000To record Sales-type lease with StarrCompany at inception and cost of leasedequipment.



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yp ( )

Example 8.6: (Contd.) Contd.

1/2 Cash 10,000Intercompany Lease Receivable 10,000

To record receipt of first payment onintercompany lease.

12/31 Unearned Intercompany InterestRevenue [(31,000-$4,494) x 0.08]

2,120

Intercompany Interest Revenue 2,120

To recognize interest earned for first year ofintercompany sales-type lease.



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yp ( )

Example 8.6: (Contd.) Journal entries of Starr Company for Year 2001:

1/2 Lease Equipment-Capital Lease 36,506Intercompany Liability underCapital Lease (net) 36,506

To record intercompany capital lease atinception.

1/2 Intercompany Liability under CapitalLease(net) 10,000

Cash 10,000To record lease payment for first year ofintercompany lease.



96/195


yp ( )

Example 8.6: (Contd.) Contd.12/31 Intercompany Interest Expense

[($36,506-$10,000) x 0.08] 2,120

Intercompany Interest Payable 2,120

To record accrued interest on intercompanylease obligation on 12/31/2001.

12/31Depreciation Expense ($36,560/6) 6,084

Lease Equipment-Capital Lease 6,084

To record depreciation expense (straight-line method) forfirst year of intercompany lease. (Six-year economic life ofleased equipment is used because lease contains a

bargain purchase option.)



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yp ( )

Example 8.6: (Contd.) The selected ledger accounts for both

companies relative to the lease are as follows:PALM CORPORATION

Intercompany Lease Receivable

01/02/01 41,000a

10,000b 01/02/0110,000c 01/02/02

10,000d 01/02/0310,000e 01/02/04

1,000f 01/02/05

0Bal on 01/02/05



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yp ( )


a. Inception of lease

b. Receipt of first payment

c. Receipt of second payment

d. Receipt of third payment

e. Receipt of fourth payment

f. Receipt of purchase option



99/195


yp ( )


Unearned Intercompany Interest Revenue

4,494 a 01/02/01

12/31/01 2,120b

Bal. 2,37412/31/02 1,490 c Bal. 88412/31/03 809 d Bal. 7512/31/04 75 e Bal. 0Bal on 12/31/04 0



100/195


yp ( )


a. Inception of lease ($41,000 - $36,506)

b. Interest for year [($31,000 - $4,494) x 0.08)]

c. Interest for year [($21,000 - $2,374) x 0.08)]

d. Interest for year [($11,000 - $884) x 0.08)]

e. Interest for year [($1,000 - $75) x 0.08)];Adjusted $1 for rounding.



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y ( )


Intercompany Interest Revenue2,120a 12/31/01

12/31/01 2,120b

1,490c

12/31/0212/31/02 1,490d

809e 12/31/0312/31/03 809f

75g 12/31/0412/31/04 75h

Bal on 12/31/04 0

Intercompany Lease of Property under Capital/Sale-TypeLease (Contd.)

E l 8 6 (C td )


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a. Interest for Year 2001b. Closing entryc. Interest for Year 2002

d. Closing entrye. Interest for Year 2003f. Closing entry

g. Interest for Year 2004;Adjusted $ 1 forrounding.h. Closing entry



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STARR COMPANYLeased EquipmentCapital Lease

01/02/01 36,506a

6,084b 12/31/016,084c 12/31/026,084d 12/31/03

6,084e

12/31/046,085f 12/31/056,085g 12/31/06

0 Bal on 01/02/06



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a. Capital lease at Inceptionb. Depreciation for Year 2001

c. Depreciation for Year 2002

d. Depreciation for Year 2003e. Depreciation for Year 2004

f. Depreciation for Year 2001;Adjusted $1

for rounding.g. Depreciation for Year 2001;Adjusted $1

for rounding.


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a. Capital lease at inception

b. First lease payment

c. ($10,000-$2,120 interest)

d. ($10,000-$1,490 interest)

e. ($10,000-$890 interest)

f. ($10,000-$75 interest)


(C )


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Intercompany Interest Expense12/31/01 2,120a

2,120b 12/31/01

12/31/02 1,490c

1,490d 12/31/0212/31/03 809e

809f 12/31/0312/31/04 75g

75h 12/31/040 Bal on 12/31/04


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E l 8 6 (C td )


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Depreciation Expense12/31/01 6,084a

6,084b 12/31/0112/31/02 6,084c

6,084d 12/31/02

12/31/03 6,084e6,084f 12/31/03

12/31/04 6,084g

6,084h 12/31/04

12/31/05 6,085i 6,085j 12/31/0512/31/06 6,085k

6,085l 12/31/06

0 Bal on 12/31/06


Example 8 6: (Contd )


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a. ($36,506/6)b. Closing entryc. ($36,506/6)d. Closing entry

e. ($36,506/6)f. Closing entryg. ($36,506/6)h. Closing entry

i. ($36,506/6); Adjusted $1 for rounding.j. Closing entryk. ($36,506/6);Adjusted $1 for rounding.l. Closing entry




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Partial working paper eliminations (injournal entry format) for theconsolidated financial statements for

year 2001 and year 2002 are as follows(note: intercompany interest revenueand intercompany interest expense areself-eliminated on the same line of theincome statement section of theworking paper for consolidated financialstatements):


E l 8 6 (C td )


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PALM CORPORATION AND SUBSIDIARYPartial Working Paper EliminationsDecember 31, 2001

(b) Intercompany Liability under Capital Lease-Starr 26,506Intercompany Interest Payable-Starr 2,120

Unearned Intercompany Interest Revenue- Palm 2,374Intercompany Sales-Palm 36,506Intercompany Cost of Goods Sold-Palm 30,000Intercompany Lease Receivables-Palm 31,000Leased Equipment-Capital Lease-Starr

($36,506-$30,000-$1,084) 5,422Depreciation Expense-Starr[($36,506-$30,000)/6] 1,084

To eliminate intercompany accounts assciated withintercompany lease and to defer unrealized portion ofintercompany gross profit on sales-type lease.(Income tax



E l 8 6 (C td )


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(b) Intercompany Liability under Capital Lease-Starr 18,626

Intercompany Interest Payable-Starr 1,490Unearned Intercompany Interest Revenue-Palm 884

Retained Earnings-Palm [($36,506-$30,000)-$1,084] 5,422Intercompany Lease Receivables-Palm 21,000

Leased Equipment-Capital Lease-Starr($5,422-$1,084) 4,388Depreciation Expense-Starr 1,084

To eliminate intercompany accounts assciated withintercompany lease and to defer unrealized portion ofintercompany gross profit on sales-type lease.(Income tax



E l 8 6 (C td )


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Note:The elimination of 12/31/2001

removes the parent companysintercompany sale and cost of goodssold.The subsidiarys depreciation

expense of $1,084 for 2001

represents the realization of a portionof the parents gross profit margin onthe intercompany sale.


E l 8 6 (C td )


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In Year 2002 elimination, the original$6,506 unrealized gross profitelement in the subsidiarys leased

equipment has been reduced by$1,084 (the reduction of thesubsidiarys year 2001 depreciation

expense).

Intercompany Sales of IntangibleAssets


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Assets

The working paper eliminations forintercompany gains on sales ofintangible assets are similar to those for

intercompany gains in depreciable plantassets, except that no accumulatedamortization is involved.

Intercompany Sales of Intangible Assets(Contd.)

Example 8 7:


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Example 8.7:

On 1/2/2002 Palm sold a patent to itswholly own subsidiary,Starr, for$40,000. The carrying amount of this

patent for Palm is $32,000. The patent had a remaining economic

life of 4 years on 1/2/2002 and wasamortized by the straight-line method.

The working paper elimination for year2002 and year 2003 related to thisintercompany transaction is as follows:




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(c) Intercompany Gain on Sale of

Patent--Palm ($40,000- $32,000) 8,000Amortization ExpenseStarr($8,000/4) 2,000

Patent-Starr ($8,000-2,000) 6,000To eliminate unrealized intercompany gain inpatent and related amortization.(Income taxeffects are disregarded.)




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(c) Retained Earnings--Palm

($8,000-$2,000) 6,000Amortization ExpenseStarr($8,000/4) 2,000Patent-Starr ($6,000-$2,000) 4,000

To eliminate unrealized intercompany gain inpatent and related amortization.(Income taxeffects are disregarded.)

Acquisition of Affiliates Bonds inAn Open Market


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An Open Market

Intercompany gains and losses may berealized by the consolidated entitywhen one affiliate acquires outstanding

bonds of another affiliate in the openmarket.

No realized or unrealized gain or loss

would result from the direct acquisitionof one affiliates bonds by anotheraffiliate.

Acquisition of Affiliates Bonds inAn Open Market (Contd )


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An Open Market (Contd.)

Example 8.8:Assume that on 1/2/2001, Sage (thepartially owned subsidiary) issued to

the public $500,000 face account of10% bonds due 1/1/2006.

The effective interest rate (market yield

rate) is 12%. Interest was payableannually on 1/1.

Acquisition of Affiliates Bonds in An Open Market(Contd.)



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The net proceeds of the bond issue toSage were $463,952, computed asfollows (bond issue costs are

disregarded):Present value of $500,000 in five yearsat 12%, with interest paid annually($500,000 x 0.567427) $ 283,713

Add: Present value of $50,000 eachyear for five years at 12%

($50,000 x 3.604776) 180,239Proceeds of bond issue $ 463,952




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The following entries were recordedby Sage for year 2001 regardingthe issuance of the bond and the

accrued interest:




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2001 Sage Company Journal Entries1/2 Cash 463,952

Discount on Bonds Payable 36,048Bonds Payable 500,000

To record issuance of 10% bonds dueJan. 1, 2006, at a discount to yield 12%.

12/31 Interest Expense ($463,952 x 0.12) 55,674Interest Payable($500,000 x 0.10) 50,000

Discount on BondsPayable 5,674

To record accrual of annual interest on10% bonds.




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Assume that on 12/31/2001, Post (theparent company) had cash available forinvestment.

The effective interest rate at the time is15%. Thus, Sages bonds can bepurchased in the open market at asubstantial discount.

Post acquired 60% of Sages bonds on12/31/2001 at $257,175 plus $30,000accrued interest.




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The acquisition cost of 60% of Sagesbonds is computed as follows:

Present value of $300,000 in four years

at 15%, with interest paid annually($300,000 x 0.571753) $ 171,526

Add: Present value of $30,000 eachyear for four years at 15%

($30,000 x 2.854978) 85,649Cost to Post Corporation of $300,000face amount of bonds $ 257,175




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Post prepared the following journalentry on 12/31/2001 to record theacquisition of Sages bonds:

Investment in Sage CompanyBonds 257,175Intercompany InterestReceivable 30,000

Cash 287,175To record acquisition of $300,000 faceamount of Sage Companys 10% bondsdue Jan. 1, 2006, and accrued interest forone year.




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The following entry is prepared by Sage(the bond issuer) on 12/31/2001 whennotified by the parent company of thisacquisition:Bonds Payable 300,000Discount on IntercompanyBonds Payable ($30,374 x 0.6) 18,224

Interest Payable ($50,000 x 0.6) 30,000

Intercompany Bonds Payable 300,000Discount on Bonds Payable 18,224Intercompany Interest Payable 30,000

To transfer to intercompany accounts all amountsattributable to bonds acquired by parent company in open

market.




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From the viewpoint of the consolidatedentity, Posts acquisition of Sages bondsis equivalent to the extinguishment of thebonds at a realized gain of $24,601,

computed as follows:Carrying amount of Sage Companysbonds acquired by Post Corporation onDec.31,2001($300,00018,224) $ 281,776

Less: Cost of Post Corporationsinvestment 257,175

Realized gain on extinguishment ofbonds $ 24,601




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The $24,601 realized gain is notrecorded in the accounting records ofeither the parent company or thesubsidiary.

However, it is recognized in the workingpaper elimination (in journal entry

format) on 12/31/2001, shown asfollows:




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POST CORPORATION AND SUBSIDIARYPartial Working Paper EliminationDecember 31,2001

(e) Intercompany Bonds PayableSage 300,000

Discount on IntercompanyBonds Payable-Sage 18,224Investment in SageCompany Bonds-Post 257,175

Gain on Extinguishment ofBonds-Sage 24,601

To eliminate subsidiarys bonds acquired by parentand to recognize gain on the extinguishment of thebonds.(Income tax effects are disregarded.)



132/195



Notes to the partial working paperelimination:

1. The intercompany interest receivable-- Post ($30,000) and intercompanyinterest payable-Sage ($30,000) areoffset in the working paper

elimination.



133/195



2. The gain is attributes to Sagethebond issuer (the subsidiary).

This treatment assumes that parentsopen market acquisition of thesubsidiarys bonds was, insubstance, the extinguishment of the

bonds by the subsidiary.



134/195



3. The gain is included in theconsolidated income statement ofPost and subsidiary for the yearended 12/31/2001.

If the gain is material, it is displayedas an extraordinary item.


135/195


136/195

Accounting for Gain (from Acquisition ofAffiliates Bonds) in Subsequent Years


137/195


Affiliate s Bonds) in Subsequent Years

In the following four years, the realizedgain which is unrecorded by eitheraffiliate on the date of acquisition,is

reported by the consolidated entitythrough the differences in the twoaffiliates interest expense and the

interest revenue.

Accounting or ain ( rom Acquisition oAffiliates Bonds) in Subsequent Years(Contd )


138/195


(Contd.)

The accounting for the bond interest bythe two affiliates for the year ended12/31/2002 and related ledger accounts

for four remaining years for bothcompanies are as follows:



139/195


(Contd.)

2002 Post Corporation Journal Entries1/2 Cash 30,000

Intercompany InterestReceivable

30,000

To record receipt of accrued intereston Sage Companys 10% bonds.12/31 Intercompany Interest

Receivable 30,000Investment in Sage Company

Bonds 8,576Intercompany InterestRevenue 38,576

To accrue annual interest on SageCompanys 10% bonds ($257,175 x

0 15 =$38 576)



140/195


(Contd.) 2002 Sage Company Journal Entries

1/2 Intercompany Interest Payable 30,000Interest Payable 20,000

Cash 50,000To record payment of accrued interest on 10%bonds.

12/31 Intercompany Interest Expense 33,813Interest Expense 22,542Intercompany Interest Payable 30,000Interest Payable 20,000Discount on Intercompany Bonds

Payable 3,813Discount on Bonds Payable 2,542To accrue annual interest on 10% bonds.Interest is computed as follows:Intercompany ($300,000-$18,224) x 0.12=$33,813Other ($200,000- $12,150) x 0.12= $22,542



141/195


(Contd.)

POST CORPORATIONInvestment in Sage Company Bonds

12/31/01 257,175 a

12/31/02 8,576 b

12/31/03 9,863 c

12/31/04 11,342 d

12/31/05 13,044 eBal on 12/31/05 300,000



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a.Acquisition of $300,000 face amount of bondsb.Accumulation of discount ($38,576-$ 30,000)

c.Accumulation of discount ($39,863-$30,000)

d.Accumulation of discount ($41,342-$30,000)

e.Accumulation of discount ($43,044-$30,000)

(Contd.)


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144/195


a.($257,175 x 0.15)b.Closing entry

c.($265,751 x 0.15)

d.Closing entry

e.($275,614 x 0.15)

f. Closing entry

g.($286,956 x 0.15),Adjusted $ 1 for rounding.

h. Closing entry

(Contd.)

Accounting for Gain (from Acquisition ofAffiliates Bonds) in Subsequent Years(Contd )


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Sage CompanyIntercompany Bonds Payable

300,000a 12/31/01

300,000Bal on 12/31/01

a. Bonds acquired by parent company

(Contd.)



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Discount on Intercompany Bonds Payable12/31/01 18,224a

3,813b 12/31/02

4,271c 12/31/034,783d 12/31/045,357e 12/31/05

0Bal on 12/31/05

(Contd.)



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a.Bonds acquired by parent company

b.Amortization ($33,813-$30,000)

c.Amortization ($34,271-$30,000)

d.Amortization ($34,783-$30,000)

e.Amortization ($35,357-$30,000)

(Contd.)



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Intercompany Interest Expense12/31/02 33,813a

33,813b 12/31/0212/31/03 34,271c

34,271d 12/31/0312/31/04 34,783e

34,783f 12/31/04

12/31/05 35,357g35,357h 12/31/05

0 Bal on 12/31/05

(Contd.)



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a.[($300,000-$18,224) x 0.12]b.Closing entry

c.[($300,000-$14,411) x 0.12]

d.Closing entry

e.[($300,000-$10,140) x 0.12]

f. Closing entry

g.[($300,000-$5,357) x 0.12]

h. Closing entry

(Contd.)

Accounting or ain ( rom Acquisition oAffiliates Bonds) in Subsequent Years(Contd.)


150/195


A summary of the differencesbetween the intercompany interestrevenuePost and intercompany

interest expenseSage is asfollows:

(Contd.)



151/195


Year Ended

Dec. 31,

PostCorporationsIntercompany

Interest

Revenue

SageCompanys

IntercompanyInterest

Expense

Difference-RepresentingRecording of

Realized Gain

2002 $ 38,576 $ 33,813 $ 4,763

2003 39,863 34,271 5,592

2004 41,342 34,783 6,559

2005 43,044 35,357 7,687Totals $ 162,825 $138,224 $ 24,601

(Contd.)



152/195


Notes to the above summary table:1. Although the acquisition gain is not

recognized by either affiliate at

acquisition, the gain is recognized bythe consolidated entities in thefollowing four years through thedifferences in the intercompany

interest revenuePost and theintercompany interest expenseSage.

(Contd.)



153/195


2. The total of differences betweenparents intercompany interestrevenue and subsidiary

intercompany interest expense isequal to the realized gain on parentsacquisition of subsidiarys bonds.

(Contd.)

Working Paper Elimination on 12/31/2002(One Year Subsequently to Acquisition ofBonds)


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Bonds)

The working paper elimination for the bondsand interest on 12/31/2002 is as follows:(e)Intercompany Interest Revenue-Post 38,576

Intercompany Bonds Payable-Sage 300,000Discount on Intercompany Bonds Payable-Sage 14,411Investment in Sage Company Bonds- Post 265,751Intercompany Interest Expense-Sage 33,813Retained Earnings-Sage($24,601 x 0.95) 23,371

Minority Interest in Net Assets of Subsidiary($24,601 x 0.05) 1,230

To eliminate subsidiarys bonds owned by parent company, andrelated interest revenue and expense; and to increase subsidiarysbeginningretained earnings by amount of unamortized realizedgain on the extinguishments of the bonds.(Income tax effects are

disregarded )

Working Paper Elimination on 12/31/2002(One Year Subsequently to Acquisition ofBonds) (Contd )


155/195


Bonds) (Contd.)

Note to the above working paperelimination:

The foregoing working paper elimination

reduces the consolidated income(before minority interest) by $4,796 (thedifference between the intercompanyinterest revenue and intercompany

interest expense for year 2002).

Working Paper Elimination on 12/31/2002(One Year Subsequently to Acquisition ofBonds) (Contd )


156/195


Bonds) (Contd.) Note (contd.):

This is because the entire gain of $24,601had been recognized in the consolidatedincome statement of year 2001.

This is evident by the credit of retainedearnings and the minority interest in netassets of subsidiary of $23,371 and$1,230, respectively.

If the gain of $4,796 is not eliminated, theconsolidated income of year 2002 will beoverstated by $4,796.

Working paper elimination on12/31/2002


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Similar working paper elimination foryears 2004 and 2005 would beprepared. Assume that Sage paid the

bonds in full on maturity 1/2/2006.Therefore, no further working papereliminations for the bonds would berequired.

Working paper elimination on12/31/2002 (Contd.)


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( )

The working paper elimination on12/31/2003 is as follows:(e)Intercompany Interest Revenue-Post 39,863

Intercompany Bonds Payable-Sage 300,000Discount on Intercompany Bonds Payable-Sage 10,140Investment in Sage Company Bonds- Post 275,614Intercompany Interest Expense-Sage 34,271Retained Earnings-Sage[($24,601-$4,763) x 0.95] 18,846

Minority Interest in Net Assets of Subsidiary[($24,601-$4,763) x 0.05] 992To eliminate subsidiarys bonds owned by parent company, andrelated interest revenue and expense; and to increase subsidiarysbeginningretained earnings by amount of unamortized realizedgain on the extinguishments of the bonds.(Income tax effects are

disregarded )

Effect of Intercompany Profits onMinority Interest in Net Income


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y

The following working paper eliminations forPost and its 95%-owned subsidiary (Sage)are taken from p138and p139 of chapter 7,and from pages 42,65,76, and 131of thischapter.

These eliminations are followed by a revisedelimination (which differs from the one on

p150 of chapter 7) for minority interest in netincome of subsidiary.

Intercompany Profits on MinorityInterest in Net Income (contd.)


160/195


( )

POST CORPORATION AND SUBSIDIARYWorking Paper EliminationsDecember 31, 2001

(a)Common StockSage 400,000

Additional Paid-in Capital-Sage 235,000

Retained Earnings-Sage($384,000-$4,750) 379,250Retained Earnings of Subsidiary-Post 4,750Intercompany Investment Income-Post 81,700Plant Assets(net)-Sage($176,000-$14,000) 162,000

Leasehold(net)-Sage ($25,000-$5,000) 20,000Goodwill (net)-Post($37,050-$950) 36,100Cost of Goods Sold-Sage 17,000Operating Expenses-Sage 2,000



161/195


( )

Contd.

Investment in Sage CompanyCommon Stock-Post 1,229,300

Dividends Declared-Sage 50,000Minority Interest in Net Assets ofSubsidiary ($61,000 - $2,500) 58,500



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( )

The above working paper elimination (a) isto carry out the following:

(1) Eliminate intercompany investment andequity accounts of subsidiary at the

beginning of year,and subsidiarydividends.

(2) Provide for Year 2001 depreciation andamortization on differences betweencurrent fair values and carrying amountsof Sage's identifiable net assets asfollows:



163/195


( )

Cost ofGoods Sold

OperatingExpenses

Building depreciation $ 2,000 $ 2,000

Machinery depreciation 10,000

Leasehold amortization 5,000 $ 2,000

Totals $ 17,000 $ 2,000



164/195


(3) Allocate unamortized differencesbetween combination date current fairvalues and carrying amounts toappropriate assets.

(4) Establish minority interest in net assets ofsubsidiary at beginning of year ($61,000),less minority interest in dividendsdeclared by subsidiary during year($50,000 x 0.05=$2,500).

(Income tax effects are disregarded.)



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(b)Intercompany Sales-Sage 120,000

Intercompany Costof Goods Sold-Sage 96,000

Cost of Goods Sold-Post 16,000

Inventories-Post 8,000To eliminate intercompany sales, cost ofgoods sold, and unrealized profit ininventories.(Income tax effects aredisregarded.)



166/195


(c)Intercompany Gain on Saleof Land- Post 50,000

Land-Sage 50,000

To eliminate unrealized intercompanygain on sale of land.(Income taxeffects are disregarded.)

(d)Intercompany Gain on Sale

of Machinery- Sage 23,800Machinery-Post 23,800To eliminate unrealized intercompanygain on sale of machinery.(Income taxeffects are disregarded.)



167/195


(e)Intercompany Bonds Payable-Sage 300,000Discount onIntercompany BondsPayable-Sage 18,224

Investment in SageCompany Bonds-Post 257,175

Gain on

Extinguishment ofBonds-Sage 24,601To eliminate subsidiarys bonds acquiredby parent, and to recognize gain on theextinguishments of the bonds.(Incometax effects are disregarded.)



168/195


(f)Minority Interest in Net Income ofsubsidiary 3,940Minority Interest in NetAssets of Subsidiary 3,940

To establish minority interest in subsidiarys

adjusted net incomes for Year 2001 as follows:Net income of subsidiary $ 105,000Adjustments for working papereliminations:(a) ($17,000+$2,000) (19,000)(b) (8,000)(d) (23,800)(e) 24,601

Adjusted net income of subsidiary $ 78,801Minority interest share ($78,801 x 0.05) $ 3,940


169/195

Working Paper for ConsolidatedFinancial Statements (contd.)


170/195


Partial Working Paper for Consolidated Financial StatementsFor Year Ended December 31, 2001

Statement of RetainedEarnings

Post Corp. SageCompany

EliminationInc. (Dec.)

Consolidated

Retained earnings,

beginning of year 1,348,500 384,000 (a)(379,250) 1,353,250Net income 352,600 105,000 (161,839)* 295,761

Subtotals 1,701,000 489,000 (541,089) 1,649,011

Dividends declared 158,550 50,000 (a)(50,000) 158,550

Retained earnings, endof year 1,542,550 439,000 (491,089) 1,490,461

Working Paper for ConsolidatedFinancial Statements (contd.)


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Contd.Balance Sheet / Liabilities &

Stockholders EquityPost Corp. Sage

CompanyEliminationInc. (Dec.)

Consolidated

Minority interest in net assets ofsubsidiary

(a) 58,500(f) 3,940

62,440

Total liabilities x,xxx,xxx xxx,xxx 62,440 x,xxx,xxxCommon stock, $ 1 par 1,057,000 1,057,000Common stock, $ 10 par 400,000 (a) (400,000)

Additional paid-in capital 1,560,250 235,000 (a) (235,000) 1,560,250Retained earnings 1,542,550 439,000 (491,089) 1,490,461Retained earnings of subsidiary 4,750 (a) (4,750)

Total stockholders equity 4,164,550 1,074,000 (1,130,839)

Total liabilities & stockholdersequity x,xxx,xxx x,xxx,xxx (1,068,399) x,xxx,xxx

Net decrease in revenue ( and gains): $81,700 + $120,000 + $50,000 + $23,800 - $24,601 $250,899Less: Net decrease in costs and expenses: $96,000 + $16,000 -$19,000 - $3,940 89,060Decrease in combined net incomes to compute consolidated net income $161,839#Adecreasein dividends and an increasein retained earnings


172/195

Working Paper for ConsolidatedFinancial Statements( for Year 2002)


173/195


Continued with the example of Post andits subsidiary (Sage), the followings areselected Post's t-accounts(investment

in Sage, retained earnings) and Sage'st-account of retained earnings.

Review of these accounts will help in

understanding the working paper forconsolidated financial statements of

Year 2002.


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Working Paper for ConsolidatedFinancial Statements( for Year 2002) (cont.)


175/195


a.Total cost of business combinationb.Dividend declared by Sagec.Net income of Saged.Amortization of differencese.Amortization of goodwillf. Dividend declared by Sageg.Net income of Sageh.Amortization of differencesi.Amortization of goodwill

j. Dividend declared by Sagek.Net income of Sagel.Amortization of differencesm. Amortization of goodwill



176/195


Retained Earnings

1,050,000a 12/31/99457,050b 12/31/00

12/31/00 158,550 c

318,400d 12/31/0112/31/01 158,550 e

1,508,350 Bal on 12/31/01



177/195


a.Balance

b.Close net income available for dividends

c.Close Dividends Declared account

d. Close net income available for dividends

e.Close Dividends Declared account



178/195


Retained Earnings of Subsidiary4,750a 12/31/00

34,200b 12/31/01

38,950 Bal on 12/31/01

a.Close net income not available fordividends

b.Close net income not available fordividends

Working Paper for ConsolidatedFinancial Statements( for Year 2002) (con

chapter 8 consolidated finanical statemetns

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